GuangDong SongYang Recycle Resources CO.,LTD's (SHSE:603863) price-to-sales (or "P/S") ratio of 7.3x may look like a poor investment opportunity when you consider close to half the companies in the Forestry industry in China have P/S ratios below 1.3x. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/S.

How GuangDong SongYang Recycle ResourcesLTD Has Been Performing

As an illustration, revenue has deteriorated at GuangDong SongYang Recycle ResourcesLTD over the last year, which is not ideal at all. One possibility is that the P/S is high because investors think the company will still do enough to outperform the broader industry in the near future. However, if this isn't the case, investors might get caught out paying too much for the stock.

What Are Revenue Growth Metrics Telling Us About The High P/S?

GuangDong SongYang Recycle ResourcesLTD's P/S ratio would be typical for a company that's expected to deliver very strong growth, and importantly, perform much better than the industry.

In reviewing the last year of financials, we were disheartened to see the company's revenues fell to the tune of 3.3%. Regardless, revenue has managed to lift by a handy 29% in aggregate from three years ago, thanks to the earlier period of growth. Although it's been a bumpy ride, it's still fair to say the revenue growth recently has been mostly respectable for the company.

This is in contrast to the rest of the industry, which is expected to grow by 13% over the next year, materially higher than the company's recent medium-term annualised growth rates.

With this in mind, we find it worrying that GuangDong SongYang Recycle ResourcesLTD's P/S exceeds that of its industry peers. Apparently many investors in the company are way more bullish than recent times would indicate and aren't willing to let go of their stock at any price. Only the boldest would assume these prices are sustainable as a continuation of recent revenue trends is likely to weigh heavily on the share price eventually.

The Bottom Line On GuangDong SongYang Recycle ResourcesLTD's P/S

We'd say the price-to-sales ratio's power isn't primarily as a valuation instrument but rather to gauge current investor sentiment and future expectations.

The fact that GuangDong SongYang Recycle ResourcesLTD currently trades on a higher P/S relative to the industry is an oddity, since its recent three-year growth is lower than the wider industry forecast. When we see slower than industry revenue growth but an elevated P/S, there's considerable risk of the share price declining, sending the P/S lower. Unless there is a significant improvement in the company's medium-term performance, it will be difficult to prevent the P/S ratio from declining to a more reasonable level.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 3 warning signs with GuangDong SongYang Recycle ResourcesLTD, and understanding them should be part of your investment process.

If strong companies turning a profit tickle your fancy, then you'll want to check out this free list of interesting companies that trade on a low P/E (but have proven they can grow earnings).

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